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Sterling Bancorp (NYSE:STL)

Q3 2010 Earnings Call Transcript

November 1, 2010 10:00 am ET

Executives

Edward Nebb – IR

John Millman – President

John Tietjen – EVP & CFO

Analysts

Lana Chan – BMO Capital Markets

Timur Braziler – KBW

Dave Peppard – Janney

Frank Barkocy – Mendon Capital

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Sterling Bancorp 2010 Third Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (Operator instructions) And as a reminder, this conference is being recorded.

I would now like to turn the conference over to Edward Nebb. Please go ahead.

Edward Nebb

Thank you very much, Linda. Good morning, everyone. Thank you for joining us. Our news release announcing Sterling's third quarter 2010 results was issued today prior to the market open. We hope you've had a chance to review it. The release has also been posted to the company's website.

Before turning to the discussion of financial results, let me remind you that any comments made today about future financial results or other future events are forward-looking statements under the Securities Exchange Act of 1934. Actual results may differ substantially from such forward-looking statements. The amounts of any dividends in 2010 and beyond will depend on the company's future results of operations, financial condition, and other relevant factors. A discussion of the factors that could cause actual results to vary is contained in Sterling's annual and quarterly reports as filed with the SEC.

This morning, we will have introductory remarks from Mr. John Millman, President of Sterling Bancorp; and Mr. John Tietjen, Chief Financial Officer. And after their remarks, we will be happy to take your questions.

And so without further ado, let me turn the call over to Mr. Millman.

John Millman

Thank you, Ed and good morning, everyone. Welcome to our conference call for the third quarter ended September 30th, 2010. Sterling's results for the 2010 third quarter clearly demonstrate the company's fundamental strengths, the value of our growth strategies, and our willingness to take decisive actions to improve and maintain credit quality.

Among the key developments in the quarter, credit quality was enhanced significantly as we accelerated the resolution for majority of our nonaccruals, primarily in lease financing and recognized charge-offs of $15.9 million. As a result, nonaccruals are now at $6.3 million, a two-thirds decrease from a year ago and the lowest level over the past three years. As a percent of total loans, nonaccruals are now 47 basis points versus 1.6% a year ago. And the allowance as a percentage of nonaccruals tripled to 289.5% from the 2009 third quarter.

Due to the additional $8.5 million loss provision related to this accelerated resolution strategy, we did incur a net loss available to common shareholders of $3.3 million for the quarter. Had we not taken this aggressive approach, our non-GAAP net income available to common shareholders would have been $2.6 million on a pretax basis, excluding the additional loan loss provision. That is an increase of nearly 50% over comparable 2009 figure of $1.8 million.

Diluted EPS was $0.10 in both periods, reflecting the fact that weighted average shares outstanding increased from about 18.1 million to 26.8 million due to our successful March 2010 stock offering.

Loan growth was substantial, with portfolio loans rising 15% from a year ago. Adjusting for the planned reduction of the lease financing portfolio, we have grown our lending business by selectively adding new customer relationships that need our rigorous underwriting standards in markets that are underserved by our competition.

Our new business initiatives are doing very well. For example, our Warehouse Lending Group is fully meeting our expectations and our investment in building for – in building the accounts receivable management, factoring and import trade finance business both through acquisitions and organic growth continued to deliver strong volume and increasing noninterest income.

Total assets reached $2.3 billion at the end of the third quarter, setting an all-time record. Sterling has been able to grow in a prudent and fundamentally profitable manner, despite the fact that the general economic news is far from encouraging. Many economists, government agencies, and corporate leaders have noted that there is no convincing evidence of a meaningful and sustained recovery. For this reason, we concluded that it is prudent and appropriate to further reinforce Sterling's credit quality.

We have taken actions that should both avoid pressure from an uncertain economy and improve our earnings performance, beginning in the fourth quarter. In the 2010 third quarter, we accelerated the resolution of certain nonaccruals, primarily in the area of lease financing. Our nonaccruals in this category have been elevated due to the impact of the recession on the small to mid-size borrowers, typically served by our leasing business. These are primarily small ticket items and the performance of this portfolio is not representative of Sterling's solid overall asset quality.

Applying a more aggressive methodology to these lease financing credits, we charged off $15.9 million in the recent quarter. We believe the aggressive resolution of this category of nonaccruals significantly reduces our exposure at a time when the pace of the economic recovery is unsteady. Following the charge-offs, total nonaccruals ended the quarter at $6.3 million, a decrease of more than 65%. This is the lowest level of nonaccruals since September of 2007 and essentially marks a return to pre-recession levels.

As I noted earlier, this action has had a very positive effect on our asset quality as reflected in some key metrics. Our ratio of nonaccrual loans to total loans improved to 0.47% at September 30th, 2010 from 1.6% a year earlier. The allowance for loan losses as a percent of nonaccrual loans tripled to 289.5% at September 30th, 2010 from 96.5% at September 30th, 2009.

Our capital levels remain strong and give Sterling the capacity to continue our strategic growth initiatives. At September 30th, 2010, the tangible common equity ratio was 7.05% and all of our capital ratios exceeded the well-capitalized requirement.

While the pace of the economic recovery remains unsteady, we believe Sterling has the key elements to continue building shareholder value and we have a strong capital foundation to support business expansion. Our success in attracting new customer relationships continue to drive responsible loan and deposit growth and we continue to offer a range of financial solutions along with unsurpassed service that set us apart from our competitors.

We are very optimistic about our ability to deliver solid financial performance in the 2010 fourth quarter and 2011 for a number of reasons. The actions we have taken in the third quarter to accelerate resolution of nonaccruals should significantly reduce the risk to future earnings. We also should see the loan provision in the next several quarters trend toward historic levels, given our expectation for credit trends and the economy.

We continue growth – we continue – our continued growth in earning assets in the fee-producing businesses should be reflected in greater income generation capacity. We are still deploying the capital raised through our March stock offering and therefore, our asset mix still reflects a relatively high level of short-term lower yielding investment securities. As we respond to the demand from quality borrowers, we should be able to shift our asset mix to a greater proportion of loans with the resulting jump in yield.

Based upon these factors, we currently expect an improvement in net income, beginning in the 2010 fourth quarter. By reducing our exposure to a continued soft economy and resolving the majority of our nonaccruals, we can focus all our attention on capturing the opportunities in our marketplace. We will continue to dedicate our strong resources to building new quality loan and deposit relationships, deploying our capital prudently and profitably, and delivering growing shareholder value.

Now, I will turn the call over to John Tietjen.

John Tietjen

Thank you, John. Good morning, everyone. I would like to provide you with some additional detail on our performance for the third quarter. Looking at some of the key factors that contribute to our performance, net interest income, on a tax equivalent basis, was $21.6 million for the 2010 third quarter compared to $22.3 million a year ago. This primarily reflected higher average loan and investment security balances, reduced borrowings and lower funding costs, offset by the impact of lower yields on loans and securities and higher interest-bearing deposit balances.

The growth in loans reflected the success of our business development activities. The reduced yield on loans reflected the shift in the portfolio mix as we intentionally reduced lease financing receivables and have redeployed those assets into lower yielding loan categories. Higher investment securities balances and lower yields thereon reflected the implementation of our asset liability management strategy to invest in shorter-term lower yielding instruments, thereby providing greater flexibility in responding to loan growth and changes in the economic environment.

Our net interest margin has remained one of the strongest among our peers at 4.11% for the third quarter of 2010. The margin has decreased from 4.57% last year, primarily because of the factors discussed above and the deployment of the proceeds of our short term – of our stock offering in March into short-term lower yielding investment securities.

Noninterest income was up 11.3% to $13.1 million for the third quarter of 2010. This increase primarily reflected higher accounts receivable management, factoring and import trade finance fees, due to our expansion of that business through an acquisition, as well as organic growth. Noninterest expenses were relatively steady at $23.8 million for the 2010 third quarter versus $23.2 million a year ago. Lower professional fee expenses largely offset higher compensation and occupancy expenses due to the growth of the business.

Turning to the balance sheet, average loans held in portfolio for the 2010 third quarter net of unearned discount were $1.3 billion, up from $1.1 billion a year ago. When comparing these amounts, please keep in mind that leasing balances are down approximately $59 million due to planned reduction of the leasing portfolio.

Investment securities averaged $784 million for the 2010 third quarter, up from $727 million a year ago. The major increase occurred in short-term investment securities, reflecting the deployment of the proceeds of our March stock offering.

Total deposits for the 2010 third quarter averaged $1.6 billion compared with $1.3 billion a year ago. We continued to build our solid core noninterest-bearing demand deposits, which remain a key factor in our high net interest margin. Average noninterest-bearing demand deposits rose to $478 million for the third quarter of 2010, up more than 9% from $438 million a year ago. Demand deposits have grown as a result of balances maintained principally by our lending customers, as well as business development activities in our professional banking area.

The largest shift in interest-bearing deposits occurred in time deposits where average balance rose by nearly $205 million. This largely reflected our use of the CDARS which offers a flexible and highly cost-effective alternative source of deposits. Average borrowings for the 2010 third quarter decreased approximately $174 million as more cost-effective deposits have comprised a greater proportion of our funding base.

All of our regulatory capital ratios continue to exceed well-capitalized requirements as of September 30th, 2010. Our Tier 1 risk-based capital ratio stood at 13.63%, total risk-based capital was 14.7%, and Tier 1 leverage ratio was 10.35%.

Our liquidity remains strong and will support future growth. The ratio of loans held in portfolio to deposits was approximately 79% as of September 30th, 2010, giving us ample capacity to increase our lending activity.

With that, let me turn the call over to John Millman.

John Millman

Thanks, John. We feel very positive about Sterling's position at this point in the economic cycle. We have made strategic decisions that should meaningfully reduce our risk exposure. We have shown our ability to take market share and add quality assets, and our future profitability should benefit from the actions we have taken this quarter and the strong forward momentum in our business. We look forward to reporting improved results next quarter.

Now, we would be pleased to respond to your questions.

Question-and-Answer Session

Operator

(Operator instructions) And we will begin with from line of Lana Chan with BMO Capital Markets. Please go ahead.

Lana Chan – BMO Capital Markets

Hi, good morning.

John Millman

Good morning, Lana.

Lana Chan – BMO Capital Markets

I'm trying to get more color on the loan sales – or charge-offs this quarter. How much did you actually charge off in principal balance of the nonperforming leases?

John Tietjen

Roughly $11 million of the additional $15 million was in leasing. The other $4 million was in a product that's a business line of credit, which is – which are credits to borrowers similar to leasing borrowers and as a result of our actions, we took charge-offs in that area also.

I should point out that if you look at the charge-offs that John talked about, in the C&I area, we have nonaccrual loans now of about $1.1 billion and it was – million, sorry and it was – it was $3.8 million last year and leasing were under $1 million and it was $13.3 million last year. So those are the major changes in the nonaccrual area.

Lana Chan – BMO Capital Markets

Okay. And based on what you said about the pretax net income, excluding the additional loan loss provision of $2.6 million, so – am I calculating this correctly that your core loan loss provision you are seeing is roughly about $7.6 million?

John Tietjen

No. No, we were about $5.5 million for the quarter. We took an additional $8.5 million to handle these accelerated charge-offs. On a go-forward basis, we would expect our provisioning and charge-offs to be within the peer group range, significantly reduced from the $5.5 million, which would have been normal for this quarter.

Lana Chan – BMO Capital Markets

Okay. And then any update on potential repayment of TARP?

John Millman

Lana, we continue to look at that and we think at this point in the economic cycle, with all the opportunities we are seeing with the opportunities to grow the loan portfolio and given the fact it does count as regulatory capital, we are reviewing that option and we will make a decision that benefits the shareholders and the company at the appropriate time.

Lana Chan – BMO Capital Markets

Okay. Thank you.

Operator

We will go to the line of Timur Braziler with KBW. Please go ahead.

Timur Braziler – KBW

Hi, good morning.

John Millman

Hi.

John Tietjen

Good morning.

Timur Braziler – KBW

Maybe you can just give us a little bit more color as to what transpired during the quarter to make you turn more negative upon the leasing portfolio. Were there any events in particular or was it just the continued pressure felt on the middle-market clients?

John Tietjen

I don't think we turned more negative on the leasing portfolio. We had been indicating in our conference calls all year that we expected to have elevated provision and elevated charge-offs through the end of this year.

I think what's happened here is that we have seen – you have seen as much as we have a continued uncertainty on the part of, quote, "all of the experts," close the quotes, as to where the economic recovery stands. And we just decided at this point that this was the appropriate time, make this go away and hopefully be in a position to – well, not hopefully – be in a position to respond to any improvement that does come forth in the economic climate.

Timur Braziler – KBW

Okay. And what was the period-end balance on the leasing book?

John Tietjen

100 – let's call it $151 million. That's down from $212 million at September 30th last year.

Timur Braziler – KBW

Okay. And then, following up on the question of TARP, is there any kind of – did you guys see any kind of regulatory pressure this quarter posting a loss as far as the potential timing of the repayment?

John Millman

No, no. No discussion at all.

Timur Braziler – KBW

Okay. Next, regarding the mortgage banking fees, how sustainable is that $2.5 million as opposed to this quarter?

John Tietjen

I would say in the short run, we should be around those same levels, given some of the refi activity that's going on. Whether that carries into next year, difficult to tell right now. I mean, we are seeing indications that housing prices are still going to come down because of the pressure of foreclosed properties and the economic climate. What that does to the mortgage business is really very, very fluid. We are watching it on a regular basis, but I don't think I'd be comfortable making a prediction.

Timur Braziler – KBW

Okay. And then just a last question regarding margin, is there any kind of expectation in the fourth quarter, are we going to continue to see some kind of pressure?

John Tietjen

I don't think we will see much change in the margin. It was down 1 basis point compared to the second quarter. The issue is going to be, as John pointed out, as we can continue to grow our loan book and move some of the assets out of the investment portfolio into the loan portfolio, that will have a positive impact on the margin. I wouldn't see a whole lot of change on the cost of funding side however.

Timur Braziler – KBW

Okay. Perfect, thank you very much.

Operator

Next, we will go to the line of Rick Weiss with Janney. Please go ahead.

Dave Peppard – Janney

Hi, guys. How are you? It's actually Dave Peppard.

John Tietjen

Hi, Dave. How are you today?

Dave Peppard – Janney

Good, thank you. Good. In terms of the loan growth, is there any new staffing or loan officers that you are bringing on to help facilitate more growth?

John Millman

Yes. The answer is yes. We are always bringing in additional staffing. There are enormous opportunities in the market, greater opportunities than we have seen for the last decade. And we are seeing tremendous business opportunities and staffing opportunities.

Dave Peppard – Janney

Okay. Also, in the same context, what is the likelihood of a bank or a fee-based business deal in the next 12 months or so and would we see a TARP repayment before that? Is it mutually exclusive? Could you frame that a little bit for me?

John Millman

I think there is a possibility in the next 12 months you will see all of the above.

Dave Peppard – Janney

Okay. That will do it for me. Thanks, guys.

Operator

And next, we will go to the line of Frank Barkocy with Mendon Capital. Please go ahead.

Frank Barkocy – Mendon Capital

Thank you. Hi, guys.

John Millman

Good morning.

John Tietjen

Good morning.

Frank Barkocy – Mendon Capital

The outlook for the net interest margin beyond the fourth quarter, given the good inflow of core deposits that you are seeing and if indeed you are bringing in staffing that could add to your loan growth, is it possible we could see a more meaningful expansion as we get through 2011?

John Tietjen

I think, Frank, to answer your question, one of the things that I believe should be pointed out at this point is that one of the significant areas of growth for us has been in the lending to the temporary staffing agencies and in our factoring business. Those are significant contributors to the increase in noninterest income. And while they do add to the loan growth, the biggest bang for the buck is not going to be in the margin in those businesses, it's going to be down in the noninterest income area.

So to answer your question, as we expand loans in areas other than that and we get to the point where the leasing runoff is starting to lessen, we will see less of a drain. But the rates that we are putting loans on now are lower than the historic rates that we have had. So, I wouldn't see a major shift here. Clearly, as we roll out of the investments into loans, that will give us a positive push.

Frank Barkocy – Mendon Capital

Good. Thank you.

Operator

(Operator instructions) There are no further questions. Please continue.

John Millman

Thank you, operator. We thank you for your interest in Sterling and we look forward to speaking with you in the future.

Operator

This conference will be made available for replay after 12 p.m. Eastern today until November 15th at midnight. You may access the AT&T Executive Playback Service at anytime by dialing 1-800-475-6701 and entering the access code 175999. Again, that number is 1-800-475-6701 and the access code is 175999.

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive TeleConference Service. You may now disconnect.

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